A Step-by-Step Approach to Starting DIY Investing

Matthew (Matt) is a 27-year-old social worker with a Master of Social Work (MSW) degree, which he completed three years ago. Currently working in the healthcare sector, Matt has seen firsthand how financial instability can cause stress and hardship. Whether due to inadequate insurance or a lack of income sources after employment ends, the impact is profound. Many of his friends and colleagues in community-based social services observe the limitations their clients face due to low incomes and a lack of savings. Determined to avoid a similar situation, Matt, who earns $67,000 annually, is ready to start saving and investing for the long term but is unsure where to begin.

 

This blog outlines 15 essential steps to help Matt, and anyone else, build a strong foundation for DIY (Do-It-Yourself) investing.

 

1. Build an Emergency Fund

Before Matt starts investing, he needs a financial safety net. Since he is single, without dependents, has a secure salaried job, and rents his home, Matt should aim to set aside at least three months’ worth of living expenses in a high-interest savings account. This will provide a cushion for unexpected events, giving him peace of mind as he begins his investment journey.

 

2. Establish Clear Financial Goals

Matt has expressed his desire to invest to protect himself from the negative effects of poverty, both now and in retirement. However, setting more specific financial goals will help him make the most of his money. He should set clear tasks for his funds across the short, medium, and long term. Examples include:

 

Short Term (Up to 5 years):

• Ongoing contributions to his emergency fund, travel, and major purchases such as a new car.

 

Medium Term (5 to 10 years):

• Buying a home, starting a family, and paying off any loans.

 

Long Term (Over 10 years):

• Retirement savings, purchasing disability or critical illness insurance, and securing life insurance if he has financial dependents.

 

3. Assess Risk Tolerance

Risk tolerance is an investor’s ability and willingness to endure market volatility and potential losses in their investment portfolio. Understanding his risk tolerance will help Matt choose investments that align with his financial goals, time horizon, and comfort level. Many investor questionnaires, such as those from Vanguard, are available online to assist with this process.

 

4. Understand Basic Investment Principles

Matt doesn’t need to become a financial expert but learning basic concepts like risk vs. reward, diversification, and long-term investing is key. Understanding that equity investments tend to be more volatile in the short term but can yield higher returns over the long term will help him look beyond the perceived safety of savings accounts and GICs. Diversifying across different investment categories can reduce risk while enhancing long-term returns.

 

5. Learn About Exchange-Traded Funds (ETFs) and Mutual Funds

Initially, Matt believed picking a winning stock was all it took to succeed. However, after learning about diversification, he turned his attention to ETFs and mutual funds. Both types of funds pool money from many investors to buy a diversified collection of stocks, bonds, or other securities, allowing for diversification that individual investors like Matt could not achieve on their own. He discovered that while ETFs trade throughout the day and generally have lower fees, mutual funds trade only at the end of the day, at their net asset value.

 

Matt liked the idea of automatic investment plans, common with mutual funds, allowing him to set up recurring contributions to the funds of his choice.

 

6. Understand Dollar-Cost Averaging (DCA)

Matt’s next step was to understand DCA, a strategy that reduces the risk of investing a lump sum by spreading out investments over time. He had saved $30,000 in a savings account and decided to allocate $15,000 to his emergency fund, leaving $15,000 for long-term investing. Matt chose to invest the lump sum upfront and then contribute $500 monthly thereafter, ensuring he could continue investing in the market over time.

 

7. Learn About Compounding and the Time Value of Money

An essential concept for Matt is the time value of money, which explains how invested funds grow over time as returns generate additional returns. This compounding effect is especially advantageous for young investors like Matt, who have time on their side to watch their investments grow over decades.

 

8. Choose the Right Account Types

Matt already has a Defined Contribution (DC) Registered Pension Plan (RPP) through his employer, where contributions are matched, and a Pension Adjustment appears on his T4. However, he has accumulated $18,000 in a Registered Retirement Savings Plan (RRSP) contribution room and is debating whether to contribute to an RRSP or a Tax-Free Savings Account (TFSA). Additionally, a friend suggested the First Home Savings Account (FHSA), which combines features of both an RRSP and a TFSA.

 

After researching on Canada.ca, Matt decided to invest $8,000 in an FHSA for a future home purchase, and the remaining $7,000 into a TFSA.

 

9. Choose an Online Brokerage

To start investing, Matt needs to select an online brokerage. Key factors to consider include ease of use, low fees, and the ability to invest in the types of products he prefers. He decided to review the Best Online Brokers in Canada survey from MoneySense before making his choice.

 

10. Create a Simple Investment Plan

With his accounts and brokerage chosen, Matt’s next step is to create an investment plan. This plan should reflect his goals and risk tolerance:

 

Primary goal: Saving for a home

Secondary goal: Maximizing tax-advantaged investments

 

Investment accounts:

• FHSA: $8,000 initial, $500 monthly contributions
• TFSA: $7,000 initial, with additional contributions from tax refunds

 

Risk tolerance:

• FHSA: Conservative
• TFSA: Moderate

 

Investment strategy:

• FHSA: GICs and fixed income
• TFSA: 60% equity, 40% fixed income

 

11. Keep Fees Low and Avoid Overtrading

Matt is aware that excessive trading can increase costs and lower returns. He plans to invest in low-cost index mutual funds and GICs, limiting the temptation to trade frequently. As he grows more comfortable with investing, he will need to avoid the pitfall of overtrading, especially if he moves into ETFs.

 

12. Diversify Globally

Matt is committed to a globally diversified portfolio. Canada makes up only 3% of the world’s stock market, so limiting investments to domestic stocks risks underperformance. By diversifying globally, Matt can gain exposure to sectors and industries not well represented in Canada, reducing risk and enhancing returns.

 

13. Be Aware of Tax Implications

As Matt invests, he should be mindful of the tax implications of different account and investment types. Maximizing tax-advantaged accounts like his FHSA, TFSA, and RRSP is key, but if he invests in non-registered accounts in the future, understanding how capital gains, dividends, and interest are taxed will become important.

 

14. Track Investment Performance and Benchmarking

Once Matt’s portfolio is in place, it’s important to monitor performance to ensure his investments are on track to meet his goals. However, he must avoid getting caught up in constant worrying over short-term fluctuations.

 

15. Manage Behavioural Biases

Like all investors, Matt will need to manage his emotions and biases. Being aware of common behavioural traps, such as panic-selling during market downturns, will help him stay the course and maintain a long-term perspective.

 

Anticipating Matt’s Financial Future

By following these steps, Matt has taken a significant first step toward securing his financial future. With a solid emergency fund, clear goals, and a diversified investment strategy, he is well-positioned to grow his wealth over time. As he continues to learn and refine his approach, Matt can look forward to a more secure financial future—one where he can achieve his goals, such as buying a home, while safeguarding his long-term retirement prospects. The confidence and knowledge he’s building now will pay off in both financial and personal well-being in the years to come.

 

This is the 263rd blog post for Russ Writes, first published on 2024-09-23

 

Thank you to all the readers who donated to my Kidney Walk, which took place on September 22, 2024. You contributed $3,040 to the Kidney Foundation of Canada by sponsoring me. In the London, ON area, nearly $62,000 was raised, well above the target of $45,000. Thank you!

 

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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.